The fall of Spanish cajas: Lessons of ownership and governance for banks

Ownership, governance, and institutional diversity among banks are a subject of public and regulatory concern. This paper addresses this issue by using a case study of Spain, where the retail banking market was split evenly between shareholder and stakeholder banks before the crisis. We examine how institutional diversity mattered in the accumulation of risk in the pre-crisis years, in the severity of losses caused by the crisis, and in the resilience to recover from the losses. The method of analysis consists in linking the risk position of the banks in the pre-crisis period and the losses arising during the crisis to the decisions of banks to migrate from business models based on deposit financing to models based on market-debt financing. We find that cajas migrated to more vulnerable business models following the strategy of the shareholder banks, but the losses in the crisis were much higher in the former than in the latter. The paper interprets this result as evidence that what matters the most about the ownership of banks is their resilience in bad times.     

Does the ECB act as a lender of last resort during the subprime lending crisis?: Evidence from monetary policy reaction models

We investigate whether the ECB aligns its monetary policy with financial crisis risk in EMU member countries. We find that since the outbreak of the subprime crisis the ECB has significantly increased net lending and reduced interest rates when banking and sovereign debt crisis risk in vulnerable EMU countries (Greece, Ireland, Italy, Portugal, and Spain) increases, while no significant effect is identified for the pre-crisis period and relatively tranquil EMU countries (Austria, Belgium, France, Germany, and the Netherlands). These findings suggest that the ECB acts as a Lender of Last Resort for vulnerable EMU countries.     

Stock market risk in the financial crisis

In this paper, we look at the effect of the financial crisis from an angle overlooked to date in the finance literature by investigating composition effects arising from the financial crisis. A composition effect is a change in the market risk of a sector that is caused not by a direct change in that sector but by a change in another sector that affects the composition of the stock market. In the paper we investigate the pre and during crisis market risk of the industrial, banking and utilities sectors. Amongst other results, we find a positive relationship across the G12 countries between the increase in the market risk of industrials during the crisis and both the pre-crisis market risk of the banking sector and the scale of the systemic crisis in a country. The six G12 countries that experienced a major systematic banking crisis are amongst the seven countries with the largest increases in the market risk for industrials. Results drawn from our detailed analysis using US data are consistent with these findings. Finally, we show how the results add to our understanding of the linkages between the financial and real sector and conclude that composition effects of the financial crisis could have a significant chilling effect on investment in industrials, which is in addition to the effect of other linkages already documented.     

Returns and volatility spillover in the European banking industry during global financial crisis: Flight to perceived quality or contagion?

This paper empirically investigates return, volatility and leverage spillover effects between banking industrial stock markets of the major economies (ME) (Germany, UK and US) and the smaller stressed European Union countries (SE), (Italy, Ireland, Greece, Spain and Portugal) from 2002 to 2014 which includes the global financial crisis period (2007–2014). Thus the paper investigates the influence of the global crisis on the spillover between the banking industrial stock markets of Europe and the US. We apply a multivariate GARCH–GJR framework to investigate the effects of the financial crisis with respect to spillover. Our results indicate an increase in both means and volatility spillover between the major economies and the stressed EU economies from the pre-crisis to the crisis period. During the pre-crisis period there is ample evidence of spillover from Germany, UK and the US to the smaller EU economies. Little evidence of a significant spillover from the smaller economies to the major economies is found during this period. We find that return and volatility transmission mechanisms between the major economies and the smaller EU countries are asymmetric during the crisis period. During the crisis, the level and amount of spillover from the major economies increase. But now there is also clear evidence of spillover from smaller EU economies to the major economies, this is especially true for Germany and the UK. Evidence of spillover effects suggests the existence of exploitable trading strategies and has important implications to investors in the areas of option pricing, portfolio optimization and risk management.     

Investment and bank credit recovery after banking crises

In this paper, we aim to investigate (a) the dynamic adjustment of investment-to-GDP ratio and bank credit-to-GDP ratio following banking crisis episodes; (b) whether the adjustment of investment and bank credit ratios varies with several country and crisis characteristics. Based on a sample of 79 developed and emerging countries over the 1973–2010 period, our results suggest that in the aftermath of banking crises, investment ratio declines but swiftly recovers to its pre-crisis level within two to three years. Bank credit declines significantly and remains stagnated even in the medium run. In terms of country characteristics, we find that investment and bank credit ratios decline significantly more in advanced countries and countries with higher level of capital openness. In addition, investment ratio declines significantly more in countries with higher level of financial development. Finally, we split the banking crises episodes into two categories: those preceded by a domestic credit boom or a surge in net capital inflows, and those that were not preceded by such booms. We find that dynamic adjustment of investment and bank credit ratios differs substantially across the two groups. Existence of a credit boom or a surge in capital inflow in the run-up to the crisis intensifies the length and depth of the decline in investment and bank credit ratios. In fact, we find no statistically significant decline in investment following banking crises that were not preceded by a credit boom or a surge in capital inflows. These results imply that deleveraging is costly to the economy.     

The sovereign-bank rating channel and rating agencies' downgrades during the European debt crisis

We investigate the rating channel for the transmission of changes in sovereign risk to the banking sector, analysing data from Moody's, S&P and Fitch before and during the European debt crisis. Sovereign rating downgrades and negative watch signals have strong effects on bank rating downgrades in the crisis period. The impact is stronger for multiple-notch sovereign rating downgrades, and more pronounced in PIIGS countries. Secondly, we investigate rating agencies' competition in the banking sector during the same periods, finding significant differences in rating policies across the agencies. S&P credit actions tend to be the more independent ones, while Moody's appears to be more cautious, although it is by far the most likely to assign multiple-notch downgrades. In the pre-crisis period, we find no evidence that bank rating actions are linked to sovereign rating signals (nor vice versa) nor to prior bank rating changes by a competing agency.     

Comparative advantages of regional versus national banks in alleviating SME's financial constraints

This paper provides new evidence on the impact of local banking market structure on SME's access to credit and emphasize the comparative advantages of regional versus national banks in alleviating SME's financial constraints. Matching a unique dataset on bank branch-level and firm-level information for a sample of 33,165 French manufacturing firms over the 2005–2013 period, we rely on two alternative indicators to capture different dimensions of SMEs financial constraints and find significant differences in the drivers of these constraints. While higher market share of regional banks or stronger presence of geographically-focused banks helps to alleviate SMEs' short-term credit constraint, higher market share of national banks or stronger presence of geographically-diversified banks is beneficial to reduce SMEs investment cash-flow sensitivity. Moreover, in both cases, SMEs' financial constraints are strengthened in functionally-distant markets. In addition, during crisis times, the benefits of relationship banking on short-term credit constraint remain and, in some cases, are reinforced. We also find that these benefits differ according to SMEs pre-crisis financial health. Regional banks facilitate access to short term credit for firms which were more profitable before the global financial crisis and particularly those who experienced a sharp decline in profitability in troubled times, supporting the hypothesis of continuation lending by relationship banks during economic downturns.     

US government TARP bailout and bank lottery behavior

Considerable debate surrounds how the US government's TARP bailout intervention has affected the risk-taking and moral hazard behavior of U.S. banks around the global financial crisis. We examine this issue with a focus on lottery behavior introducing MAX/MIN as a new measure of lotteryness in banking to capture the loss protection from bank bailout guarantees. We find that the TARP bailout increased the likelihood of bank lotteryness and risk shifting. Lottery-like bank equities are riskier after TARP and exhibit fatter right to left tails. A consistent pattern of risk taking and lottery behavior extends both before and after the 2008–2009 crisis, engulfing the largest systemic banks (SIFIs). While confirming that lottery-like bank equities have lower short-term return, we find they exhibit better cumulative long-term return performance. Our findings have important policy implications regarding government intervention in banking crises.     

Securitization and systemic risk: An empirical investigation on Italian banks over the financial crisis

This research examines the effects of securitization on the bank's risk exposure both in terms of individual expected shortfall and marginal expected shortfall as a measure of systemic risk. The relationship between securitization activity and tail risks is especially relevant in light of the consequences for financial stability, both for the individual securitizing banks and for the market as a whole, as the financial crisis 2007–2008 reveals. By using a sample of Italian listed banks over the period 2000–2009, we find that securitizing banks have, on average, higher expected losses in case of extreme events. This adds new evidence on the main findings in the literature that focused on the evidence that risk transfer through securitization is relatively insignificant compared to the risk retained by the originating bank. We show that this risk retention is in terms of an increase of tail risk. We also find that securitization increases the probability of banks to become “systemically” riskier, but we find no difference when comparing the pre-crisis with the post-crisis period. This suggests that the systemic exposures of Italian banks are still as high as before the crisis with severe implications for financial stability.     

Calculating the probability of failure of the Norwegian banking sector

We calculate the probability of failure of the Norwegian banking sector both before and after the Norwegian banking crisis. Thus unlike previous studies of this kind we choose a sample period and banking sector where there were significant numbers of bank failures. This approach therefore gives us a better indication of the quality of the calculated risk measure. Our results indicate evidence of a steep increase in the risk inherent in this sector beginning in 1984 following the deregulation of Norwegian banks in the mid 1980s. We also find that risk levels in the sector fall after 1992 and continue to fall to pre-1982 levels by the end of our sample in December 1995.     

Credit growth in Central,Eastern, and South-Eastern Europe: The case of foreign bank subsidiaries

In this paper, we investigate the credit growth of foreign-owned banks in Central, Eastern, and South-Eastern Europe from 2000 to 2014. We intend to show whether foreign capital in the banking sector should be treated as a monolith, as it currently is in the literature. To this end, we analyse credit growth based on the status of the parent company (global systemically important banks, or G-SIBs, vs. non-GSIBs) and European Union membership of the countries of the subsidiaries. The analyses are carried out on a panel of banks with the use of the panel corrected standard error methodology. Additionally, we differentiate between the pre-crisis and crisis/post-crisis periods to identify whether the policy of parents changed after the outbreak of the crisis. We find important differences in the determinants of the credit growth of subsidiaries, indicating that foreign capital in the banking sector should not be treated as a monolith.     

Bank funding structures and risk: Evidence from the global financial crisis

This paper analyzes the evolution of bank funding structures in the run up to the global financial crisis and studies the implications for financial stability, exploiting a bank-level dataset that covers about 11,000 banks in the U.S. and Europe during 2001–09. The results show that banks with weaker structural liquidity and higher leverage in the pre-crisis period were more likely to fail afterward. The likelihood of bank failure also increases with pre-crisis bank risk-taking. In the cross-section, the smaller domestically-oriented banks were relatively more vulnerable to liquidity risk, while the large cross-border (Global) banks were more vulnerable to solvency risk due to excessive leverage. In fact, a 3.5 percentage point increase in the pre-crisis capital buffers of Global banks would have caused a 48 percentage point in their probability of failure during the crisis. The results support the proposed Basel III regulations on structural liquidity and leverage, but suggest that emphasis should be placed on the latter, particularly for the systemically-important institutions. Macroeconomic and monetary conditions are also shown to be related with the likelihood of bank failure, providing a case for the introduction of a macro-prudential approach to banking regulation.     

Liquidity risk and stock performance during the financial crisis

We investigate whether and how ex-ante liquidity risk affects realized stock returns during the global financial crisis of 2008–2009 in international equity markets. We find that stocks with higher pre-crisis return exposure to global market liquidity shocks experience larger price reductions during the crisis period. Our findings provide further insight into the comprehensive picture of the effect of liquidity risk on asset prices, especially in an international context and under different market conditions.     

Market power in CEE banking sectors and the impact of the global financial crisis

The aim of this study is to undertake an up-to-date assessment of market power in Central and Eastern European banking markets and explore how the global financial crisis has affected market power and what has been the impact of foreign ownership. Three main results emerge. First, while there is some convergence in country-level market power during the pre-crisis period, the onset of the global crisis has put an end to this process. Second, bank-level market power appears to vary significantly with respect to ownership characteristics. Third, asset quality and capitalization affect differently the margins in the pre-crisis and the crisis periods. While in the pre-crisis period the impacts are similar for all banks regardless of ownership status, in the crisis period non-performing loans have a negative effect and capitalization a positive effect only for domestically-owned banks.     

Foreign currency borrowing surrounding the global financial crisis: Evidence from Korea

We present a complete profile of firms’ foreign currency borrowing surrounding the 2007 global financial crisis. Employing extensive data from Korean firms during 2002–2012, we find that foreign currency borrowing is significantly related to firm attributes of export revenues, firm size, tangible assets and asset growth, as well as to macro-level factors. These results offer two important implications. First, macroeconomic factors alone cannot fully explain firms’ foreign currency borrowing. Second and more importantly, these firm attributes are indicative of a lower default probability and larger collateral value, which would not only facilitate borrowers’ access to foreign currency debt markets but also offer lenders a better protective cushion from possible loan defaults in the face of exchange rate changes and information asymmetry on borrowers’ credits. Period wise, asset-related firm attributes have more pronounced effects in the post- than pre-crisis period. We further show that banking regulations following the crisis effectively limit the access to foreign currency borrowing by Korean firms, most significantly by those belonging to large business groups.     

Delayed Expected Loss Recognition and the Risk Profile of Banks

This paper investigates the extent to which delayed expected loan loss recognition (DELR) is associated with greater vulnerability of banks to three distinct dimensions of risk: (1) stock market liquidity risk, (2) downside tail risk of individual banks, and (3) codependence of downside tail risk among banks. We hypothesize that DELR increases vulnerability to downside risk by creating expected loss overhangs that threaten future capital adequacy and by degrading bank transparency, which increases financing frictions and opportunities for risk‐shifting. We find that DELR is associated with higher correlations between bank‐level illiquidity and both aggregate banking sector illiquidity and market returns (i.e., higher liquidity risks) during recessions, suggesting that high DELR banks as a group may simultaneously face elevated financing frictions and enhanced opportunities for risk‐shifting behavior in crisis periods. With respect to downside risk, we find that during recessions DELR is associated with significantly higher risk of individual banks suffering severe drops in their equity values, where this association is magnified for banks with low capital levels. Consistent with increased systemic risk, we find that DELR is associated with significantly higher codependence between downside risk of individual banks and downside risk of the banking sector. We theorize that downside risk vulnerability at the individual bank level can translate into systemic risk by virtue of DELR creating a common source of risk vulnerability across high DELR banks simultaneously, which leads to risk codependence among banks and systemic effects from banks acting as part of a herd.     

Endogenous crisis dating and contagion using smooth transition structural GARCH

Detecting contagion during financial crises requires the demarcation of crisis periods. We develop a method for endogenously dating both the start and finish of crises, along with measuring contagion effects. Identification is achieved by coupling smooth transition functions with structural GARCH. In an application to US equity, bond and REIT returns for 2001–2010, we identify four phases; a pre-crisis period to July 2007, two phases of crisis up to and following October 2008, and a post-crisis phase from mid-May 2009. We detect significant contagion during the crisis and find evidence that the post-crisis period has not returned to pre-crisis relations.     

Macroeconomic adjustment and the history of crises in open economies

This paper investigates the impact of the history of crises on macroeconomic performance. We first study the impact of past banking crises on the probability of a future banking crisis. We do not detect a learning process from past banking crises. Countries that have already experienced one banking crisis generally have a higher likelihood of experiencing another crisis; and the depth of the crisis does not appear to be affected by the previous historical experience with crisis events. Evidence also suggests that, in middle-income countries, higher de jure capital account openness is associated with lower likelihood of a banking crisis, a lower ratio of non-performing loans during the crisis, and higher levels of forgone output in the crisis' aftermath. In contrast, we find that past crisis experience has a significant impact on savings. When facing considerable political risk, the past does seem to matter – countries with more people who were exposed, over their lifetime, to larger disasters will tend to save more. This association, however, does not hold for countries with more stable political systems.     

Capital regulation,deposit insurance and bank risk: International evidence from normal and crisis periods

In this paper, we examine the impact of capital regulation on bank risk and the moderating role of deposit insurance on the relationship between capital regulation and bank risk during both normal and crisis periods. Using an international sample of banks from 111 countries, our results show that stringent capital regulation reduces bank default risk, in general, during normal growth period, and this effect is not conditioned by the existence of explicit deposit insurance. Further, stringent capital regulation in place during the pre-crisis period reduces bank default risk during the crisis period, and this effect is stronger for countries with explicit deposit insurance during the pre-crisis period. These results have important policy implications to design the optimal bank regulations.     

Discretionary Loan Loss Provisions and Systemic Risk in the Banking Industry

This study examines the relation between earnings management through discretionary loan loss provisions (LLPs) and systemic risk in the U. S. banking sector using a large sample of commercial banks from 1996 to 2009. We find that earnings management increases a bank's contribution to systemic crash risk and systemic distress risk, consistent with the notion that earnings management increases information opacity, facilitates bad news hoarding, co‐moves with macroeconomic conditions, and exhibits cross‐sectional correlation and herding in earnings management. However, the effect of earnings management through discretionary LLPs on systemic risk disappears during the crisis period, consistent with weakened earnings management in crisis times. We also find that the same effect strengthens with bank uncertainty and homogenous loans, and weakens in the post‐SOX period, and when banks are audited by Big 4 auditors.